Goldilocks and the Recovery Act

SOURCE: AP/Marcio Jose Sanchez

People wait in line at an Employment Development Department office in San Jose, CA last month. The final version of the Recovery Act isn’t as good as it might have been, but it will still create or save 3 million to 3.5 million jobs over the next two years.

The $787 billion Recovery and Reinvestment Act just signed into law by President Barack Obama is being criticized and will continue to be criticized. There was no way to please everyone. Those who think it’s too big are irreconcilable with those who believe it’s too small. Those who wanted it to be faster are irreconcilable with those who want every dime to be spent with the greatest of care. From a purely economic perspective, there are few who believe this legislation is perfect. But given the politics that are inevitable in a democracy, this is the Goldilocks Recovery Plan: not too big and not too small; not too fast and not too slow—in fact, just right.

Before we examine these criticisms of the bill, let’s first review what this critical legislation will achieve. The American Recovery and Reinvestment Act is an important step in getting the U.S. economy back on track. The $787 billion package includes a mix of investments in infrastructure, science, education, and health—measures to put the United States on a greener path, help those most affected by the recession, support states that would otherwise have to lay off additional workers and cut back key public services including education, and provide tax cuts for low- and middle-income people and businesses.

The final version isn’t as good as it might have been, and will create or save fewer jobs than the original bill that the House of Representatives passed on January 28. But passage was essential, and so compromise was inevitable. This package will still create or save 3 million to 3.5 million jobs over the next two years.

Now that the dust has settled, with three Republican votes in the Senate enabling passage, but without the hoped-for bipartisan consensus, the plan faces criticism from all flanks. The size and scale of the task meant it was impossible to please all sides. Some thought that it was better to do nothing while others thought it should be larger than could conceivably pass Congress. Some wanted all the funding out the door tomorrow while others wanted it to be slower to ensure that the money was spent carefully and responsibly. But now that we have a recovery package (which will largely achieve what it set out to do) it is important to push back on the critics from all sides.

The criticisms that it is too large and laden with “pork” and thus will do little to stimulate the economy are often conflated. Senate Republicans are publicizing a list of wasteful spending that they claim amounts to $63 billion. This is just 8 percent of the total package, but that would hardly be an excuse if the money were being wasted. But let’s look at some of the biggest items on their list.

The largest is $39 billion for state fiscal stabilization. The language in the bill is clear about the use of this money, which is to be spent primarily to support “elementary, secondary, and postsecondary education and, as applicable, early childhood education programs and services.” Conservatives claim the bulk of this money will flow into public education systems around the country that are either broken or don’t need more funding, or both. But this misses the point that maintaining state education amid a deepening recession is essential to avoid job losses in the sector, and also that a good bit of the money is tied to better performance. Besides, anything left over after two years will be reallocated by the secretary of education to other states that need it.

The second item on the list is $5.5 billion to make government buildings, including court houses and border stations, more energy efficient. This is a no brainer since the federal government is the world’s largest consumer of energy and estimates that the full costs could be recovered within five to six years through reduced heating bills.

Other measures on the list include infrastructure spending totaling $7.4 billion on items such as flood prevention. The American Society of Civil Engineers gives the United States a “D minus” for the standard of its levees in their 2009 report card and estimates that there is a $100 billion shortfall. So the $275 million allocated to repair our crumbling levees in the recovery package sounds like too little rather than too much.

No doubt conservatives will be lying in wait, ready to ambush as mayors and governors make local choices about what to spend their new resources on. A recent mayors’ wish list containing items that vastly exceed the allocated dollars attracted particular mirth for spending items, such as frisbee golf courses and Harley Davidson motorcycles. But new oversight procedures mean that such projects are unlikely to see the light of day. As outlined by our colleague Reece Rushing, the plan requires regular public reports and disclosure of detailed data on investments made and progress achieved. The Recovery Act Accountability and Transparency Board will meet at least once a month to coordinate and examine spending, and to prevent waste, fraud, and abuse. It will submit quarterly and annual reports on its findings to Congress.

Finally, the Obama administration has created a website to provide detailed data on each contract awarded and, crucially, monthly updates on investments in each state and congressional district. Such transparency is revolutionary; the federal government knows the scope of the task it faces and wants the public’s help in ensuring the money is spent wisely. The bottom line: If states or municipalities try to use the money for golf courses, then they will be held accountable.

The next big criticism is that the recovery plan is too slow to get money out the door and, by implication, more focused on spending items rather than on tax cuts. Again, this does not bear scrutiny. Analysis by the Congressional Budget Office suggests that three-quarters of the plan will be spent by the end of September 2010. Critics point out that only 23 percent will be spent in fiscal year 2009, but since it runs from October to September, we are already nearly half way through and, besides, much of the infrastructure work cannot start until the thaw of spring makes it practical.

Ah-ha, crows the conservative, here is evidence that tax cuts would make more sense. It is certainly the case that tax cuts are quick out the door. But there are two problems.

First, there is no guarantee that tax cuts will be spent. Working families may (perfectly sensibly) decide to save the money or use it to pay down debt, and businesses may choose to hoard the cash rather than making investments in a grim and uncertain climate. This is why Mark Zandi of Moody’s economy.com says that spending increases provide more “bang for your buck” than tax cuts. Tax cuts can get out the government’s door fast, but they don’t necessarily do much for the economy if they end up under the mattress or sitting in a bank account.

Second, tax rebates, politically appealing though they may be, offer little long-term improvement to the national economy. They may boost demand in the short run if they are indeed spent, but unlike investment projects they do not improve America’s long-term economic competitiveness, which is vital to getting ahead in the global economy.

Improvements to health care, education, science, and infrastructure all achieve that goal. And while these are slower projects, the recession is likely to be so long and deep that it actually makes sense for some of the money authorized now to be spent in late 2010 and beyond. The Congressional Budget Office, for example, projects that the United States will not return to its level of long-run potential gross domestic product until 2014 at the earliest.

Some will also argue that social programs, rather than tax cuts, are problematic because even if the law only provides for additional spending for two years, they will not be scaled back in the future—saddling the government with long-term obligations that will be difficult to meet. This argument is generally a sneaky attempt to undermine social programs which are, in fact, among the most effective stimulus measures because the money goes to people who need to spend it for basic needs and the problem of money sitting unused is avoided.

But to treat the argument on its merits, there is little evidence that the federal government is reluctant to scale back, or let expire, social programs—as we have seen over the last 30 years. The Recovery and Reinvestment Act passed in special circumstances where expanding the federal deficit is not only acceptable, but desirable. The environment will be very different when the provisions in the act expire in 2011. Any suggestion to continue them at that point will be subject to the normal impediments faced by a new spending proposal in a difficult, fiscally constrained budget.

Another line of attack is that the cost of the bill will need to be paid back for years to come and might even bankrupt the nation because investors stop buying government debt. The truth is that the United States has a healthier fiscal position than most other developed countries. First, it’s the public debt-to-GDP ratio—the standard measure of a country’s liabilities—that counts in economics and finance, and this ratio for the United States stood at an estimated 37.9 percent in 2008. Only Britain in the Group of 7 high-income democracies had lower levels of public debt last year; Italy at 104.2 percent and Japan at 198.6 percent are way out in front.

This is little reason for complacency. After all, once federal debt is issued to pay for the recovery package, the U.S. debt-to-GDP ratio will climb above 50 percent. But with huge uncertainty in financial markets U.S. Treasury bills remain one of the safest and most popular forms of financial security, which in turn means the U.S. Treasury will be able to raise this new debt at very favorable terms. With several European countries facing the risk of sovereign default and Japan’s extraordinary level of debt, investors only have one option at present to keep safe their stock of wealth.

And when the United States comes out of the recession and its budget position returns to surplus (as the Clinton administration managed to do in the 1990s), a strong economic recovery will boost tax receipts and help bring down the relative size of public debt. This is precisely what happened from 1946 to 1981 when America’s debt-to-GDP ratio fell from the 108.6 percent that had been built up to pay for World War II to 25.8 percent 35 years later.

A final criticism of the plan comes from those who argue that the act is too timid and too small. To those people we say: You may be right. Theoretically the projected output gap in 2009 and 2010 is so large that an argument could be made for a package of $1.2 trillion. But reaching such a level may have pushed the boundaries of what is both politically and administratively doable. The coalition of Democrats and moderate Republicans would not have tolerated much more. And it is unclear how additional amounts could have been used responsibly.

Larger tax cuts would have been irresponsible for the reasons outlined above, and bigger spending cuts would have pushed the limits of what state and federal bodies can responsibly spend. There is certainly a case for making the recovery package bigger than it ended up being, but not by much given the limits in administrative capacity to manage such vast sums in such a short time period of time.

So, the Recovery and Reinvestment Act is not too big and not too small. Nor is it too fast or too slow. In fact, this Goldilocks Recovery Plan is just right.

Will Straw is Associate Director for Economic Growth at the Center for American Progress. Michael Ettlinger is Vice President for Economics at the Center. For more economic analysis and policy recommendation from the Center please go to the economy page of our website.